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Why the Fed wants to hike rates sooner rather than later

23 September 2015
Fed, funds rate, monetary policy
The main reason to begin raising interest rates in the US sooner rather than later is because of the healthy employment situation.  But it is also about the ‘emergency’ policy setting that is no longer required.
The table below shows key US economic indicators and the real Fed funds rate at the start of the last four tightening cycles compared to now.

Conditions at start of Fed rate tightening cycles
In terms of its dual mandate, the core PCE inflation is 0.9% below the average of the last four tightening cycles, but this is offset by the unemployment rate which is 0.5% below average.  However, the real Fed funds rate is 2.6% below the average rate at the beginning of the last four tightening cycles (-1.1% now vs 1.5% average).  In other words, monetary policy is on emergency settings. 
The other economic indicators (headline CPI, ECI, GDP) are all softer than the historical average, but not by 2.6%. 
On this simple historical comparison that makes no assumptions about ‘natural’ or ‘normal’ conditions, a 1% hike in the Fed funds rate (right now) would bring the variance between the economic indicators and the real Fed funds rate closer to the historical average.
This blog post has been prepared to provide general information and does not constitute 'financial advice' for the purposes of the Financial Advisors Act 2008 (Act). An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, 'AMP') make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.

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